The End or the Eye?

Volatility is coming down. The daily ranges of the market averages are tending to narrow. The market has essentially been trading sideways for the past two weeks. Following the violent swings of the previous two months, a period of relative calm is certainly welcome. But, does this climate change signal the end of the stormy weather, or is it just the eye of the hurricane?

The past few weeks have brought some parting of the clouds that had been hanging over our economy. The rate of spread of the contagion seems to be leveling off. And, whether it’s prudent or not, we’re likely to see a gradual re-opening of some businesses over the next several weeks. Any improvement is welcome, but the real issue is whether those few rays of sunshine will be enough to sufficiently heat up the economy. We’re all ready to head for the beach, but there’s still some doubt about what to wear. The market is acting like we should be wearing bikinis and Speedos, but it may turn out that the more appropriate attire is the sort of foul weather gear worn by Weather Channel reporters as the storm makes landfall.

The major averages will serve as the economy’s barometer in the weeks ahead. The market’s recovery since the March low seems to be forecasting a speedy economic recovery and sunny skies for all. We know that stocks will be heading higher well before the economy sees brighter days. But we also know that markets can get a little overly optimistic. Before you start slathering on the SPF 50, keep in mind that there are still large swaths of the economic landscape that will be plagued by storm clouds for a long time.

Continuing relative strength in Consumer Discretionary and Healthcare stocks helped the NASDAQ Composite Index (COMP) get through the week with the least damage. COMP lost 0.18% while the Dow Jones Industrial Average (DJIA) fell nearly 2%. The S&P 500 Index (SPX) was in the middle with a loss of 1.32%.

SPX ended the week near 2837. Falling below last week’s low near 2727 would indicate that the storm clouds may be returning; in that case, something in the 2500 to 2600 range would be a reasonable target. Conversely, climbing above 2880 would likely see an extension into the low-2900s. SPX is unlikely to climb above the 3000 level until the economy is well into its recovery. If the market’s prevailing trend is northward, there’ll be no cause for alarm, but it seems like a lot of good news has already been prognosticated by the rally. At this stage, the potential for disappointment and downside risk is much greater than any remaining upside potential. Seeing SPX in the 2880 to 2950 range would seem to be more of an opportunity to be defensive than to be aggressive.

The final weighted earnings per share of the S&P 500 for calendar 2019 was about $164. The estimates for calendar 2020 were as high as $185 a year ago and around $175 early this year. More recently that figure has declined to around $140 and is still falling, but it’s a wild card number. Perhaps more relevant is what the market expects for calendar 2021. Most analysts expect earnings to rebound substantially from 2020 into 2021, but probably not back to 2019 levels. If a good ballpark guess is around $150, then that would mean, with the S&P currently at about 2840, the market is trading at over eighteen times 2021 earnings. In other words, if those 2021 earnings assumptions are accurate, then the market is already as richly valued as it was at the February highs.

The Crude Oil market was hit by a bolt of lightning last week. At some point, you probably heard that the price of a barrel of crude oil went negative last Monday. It was only the May futures contract, expiring the following day, that saw negative pricing. It’s no secret over the past couple months that there is a glut of crude oil supply, and that’s not likely to change anytime soon. Meanwhile, the COVID contagion caused a very sudden and a very steep reduction in demand for crude oil, and that’s not likely to change anytime soon. Exacerbating that double-barreled supply/demand punch is a lack of available storage.

Most futures contract buyers never intend to take delivery of the underlying commodity. Only a few commercial entities might contemplate taking delivery and even then, only if they have an appropriate place to put the stuff. Individual speculators are usually urged to close out positions days or weeks in advance of the contract’s expiration to avoid the threat of a delivery squeeze. Last Monday, anyone who still owned a May crude contract was caught in a predicament in which they were forced to sell to avoid delivery. They were selling into a market in which any potential buyer knew that taking delivery was out of the question. Forced sellers and no buyers means prices plummet.

The expiration induced sell-off in the May contract pulled prices down in nearby longer-dated contracts as well. Prices for June and July crude futures also hit record lows that day but rebounded over the balance of the week. Futures for June delivery ended the week a bit above $17 per barrel. That’s still a shockingly low price, but the contract’s ability to rebound from the depressed early-week levels enabled stocks in the Energy sector to have a rare relatively good week. That sector gained about 2% for the week while the next-best U.S. equity sector, Communication Services, advanced a mere 0.52%. All the other S&P U.S. equity sectors were down for the week. The fact that the Energy sector also has the best five-week increase, up about 34%, is more a result of how oversold the sector got than a testament to the sector’s future profitability.

Gold outperformed all the equity sectors last week with a gain of about 2 ½%. The gold futures contract ended the week near $1746 about $20 per ounce below its multi-year high set two weeks ago. Gold is likely to continue to trend higher with central banks around the world slashing rates and pumping liquidity into their economies and governments around the world ramping up deficit spending to rescue their economies.

The new Earnings Season is likely to get a little stormy this week. So far, about 65% of companies reporting have beaten estimates, but that’s the lowest percentage beating in more than a decade. Worse, almost 90% of reporting companies have withdrawn guidance for future quarters. Not only will this be the week with the largest number of companies reporting, but it will also be a week in which several of the largest stocks announce their quarterly results. By happenstance, this will be the first time in more than five years that these companies will all be reporting in the same week. For what it’s worth, the last time all these companies reported in the same week, SPX was down more than 3% for the week.

This week also brings an economic report calendar that’s loaded to the gills. Some of the consensus estimates provide a sobering assessment of the degree to which the economy has slowed. Smack dap in the middle of the week is the first look at GDP for the first quarter of the year. All indications are that the first quarter saw negative GDP growth. That means if the second quarter GDP also declines, then the economy is officially in recession.